Janet Yellen’s Federal Reserve is “reasonably confident” it can drive up consumer prices. Mario Draghi says his European Central Bank’s stimulus has already “proven so far to be potent.” The Bank of England reckons inflation is “likely to return” to its target within two years.
While not quite declarations of victory, such statements show policy makers’ optimism that record-low interest rates and bond-buying will be enough to return inflation to the 2 percent range most of them eye.
Yet, central banks have repeatedly overestimated inflation since the middle of 2011, according to Marvin Barth, head of European foreign-exchange strategy at Barclays Plc in London. To him, a mounting concern is that about a third of the decade-long decline in worldwide inflation is potentially inexplicable.
If he’s right then what he calls “global missingflation” threatens the ability of Yellen and company to push up prices and raises questions over whether they will ever be able to declare mission accomplished and truly end their use of easy stimulus.
“‘Global missingflation’ likely will keep central banks nervous and should give pause to those who think downside risks to inflation are no longer a risk,” Barth, a former U.S. Treasury official, said in a report to clients on Wednesday. “It also should instill greater caution in market participants who think that ‘lowflation’ or deflation are receding risks.”
To make his case, Barth studied 27 economies to identify why consumer prices outside of food and energy dropped 0.46 percentage point in industrial nations in the decade up to December 2014 and 0.74 percentage point in emerging markets.
Once he allowed for traditional drivers of prices such as demand or productivity, he found 35 percent of the slide in global inflation hard to pin down. Among the possible reasons could be deleveraging, technological progress, globalization, aging populations or China’s deflationary impulse.
Whatever the explanation, the inflation puzzle is a reason for central banks to worry about the power of policy and may leave them reliant on factors over which they have less control such as commodities, currencies or wages to propel prices.
Worse still is the risk that financial markets and the public lose faith in policy makers to control inflation. The inflation expectations of both over the next five years may start to suggest such doubts.
It could be that the “missingflation” fades or that monetary policy still works and just needs to be deployed even more aggressively, said Barth. In Sweden, for example, the recent use of negative interest rates has boosted inflation expectations.
The current environment nevertheless means that at the very least, the Fed and its counterparts will want clear evidence of sustained inflation before they push interest rates higher, he said.
But what if central banks can no longer manage inflation? In that case policy makers will need to keep their unconventional policies for longer, injecting volatility into markets and leaving investors charging more to accept risk.
“Rather than masters of inflation, central banks begin to look like passive bystanders in the process,” said Barth.